Wallison Reinvents History

The big news in U.S. regulation last week was the release of the Financial Crisis Inquiry Commission reports. (There's a major article in the New York Times about Kabul Bank that supports warnings made in my earlier column on that scandal.) The Commission report and the two dissents discuss some of the most important topics in financial regulation, so I will devote a series of columns to the reports, beginning with the dissent of the nation's leading anti-regulator - Peter Wallison. Wallison's passion, for forty years, has been financial deregulation and desupervision. The Republican Congressional leadership appointed him to the Commission to serve as apologist-in-chief for the deregulation and desupervison that made the crisis possible.

We'll explore Wallison's dissent in greater detail in future columns, but this overview column addresses his three primary arguments: Fannie and Freddie are the Great Satans, they caused the crisis because of demands politicians put on it to purchase the subprime loans that caused the crisis, and all of this was compounded by the Fed's easy money policies.

This column discusses Wallison's views on the first two subjects while the crisis was developing. Wallison is well-known for his long-standing criticisms of Fannie and Freddie, but most people do not know the nature of those criticisms. Wallison praised subprime mortgage loan and complained that Fannie and Freddie purchased too few subprime loans. Wallison (correctly) explained that Fannie and Freddie's CEOs acted to maximize their wealth - not to fulfill any public purpose involving affordable housing. He also explained that they used accounting abuses to make themselves wealthy. He predicted that low capital costs would increase economic growth. Wallison's prior views contradict his current claims. Aspects of Wallison's prior views were correct. They support the conclusion that Fannie and Freddie were accounting control frauds.

Wallison's Ode to Low Interest Rates

http://www.aei.org/speech/16590

Testimony before the Subcommittee on Securities of the Senate Committee on Banking, Housing and Urban Affairs By Peter J. Wallison | Senate Committee on Banking, Housing, and Urban Affairs (July 19, 2000)

If capital costs are low, more capital will be available for companies that need it, capital will be allocated more efficiently, we will have faster and broader-based economic growth, and the welfare of all Americans will be enhanced.

(Parenthetically, Wallison's July 19, 2000 Senate testimony disputed the claim that there was a high tech bubble - even as the bubble was collapsing.)

Wallison's Ode to Subprime Lending

Wallison and his AEI colleague Charles Calomiris co-chaired AEI's project on financial market deregulation . They were also members of the Shadow Financial Regulatory Committee (a self-selected group of deregulatory scholars and practitioners associated with AEI).

Statement of the Shadow Financial Regulatory Committee on Predatory Lending

December 3, 2001. Statement No. 173

The Federal Reserve is in the process of drafting detailed regulations dealing with alleged problems of so-called "predatory lending" in the subprime mortgage market, and the Congress is considering actions to curb various alleged abuses in this type of lending.

Because much of what is classified as predatory lending involves loans to low-income, minority, and higher-risk borrowers, a central principle that should guide legislation and regulation in this area is the desirability of preserving access to subprime mortgage credit for such borrowers, who are most at risk of losing access to this market in the wake of misguided and punitive regulations. The democratization of consumer finance that has occurred over the past decade has created new opportunities for low-income consumers. This is now threatened by chilling effects that inappropriate regulations and laws might have on the supply of subprime credit to these consumers.

Subprime credit to low-income consumers necessarily entails higher interest rates. As recent evidence of increasing loan defaults demonstrates, this line of business is risky, and institutions will only be willing to provide such credit if interest rates are sufficiently high relative to risks and other costs of servicing consumers. One of the risks that must be borne by intermediaries is regulatory risk. Laws or regulations that place lenders at greater risk of legal liability for having entered into a loan agreement (for example, state and municipal statutes that penalize refinancings that could be deemed contrary to the interests of the borrower) generally will reduce the supply of beneficial lending as well as predatory lending. Illegal lending, however, would not be reduced; indeed, it would be encouraged.

Wallison Criticized Fannie & Freddie for Making too Few Loans to the Less Wealthy

Wallison's critique of Fannie and Freddie emphasized their failure to make more subprime loans and loans to minorities.

http://www.aei.org/speech/16994

H.R. 3703 and its Effects on Government Sponsored Enterprises

By Peter J. Wallison | House Subcommittee on Capital Markets

(September 06, 2000)

The GSE form--at least as it is embodied in Fannie Mae and Freddie Mac--contains an inherent contradiction. It is a shareholder-owned company, with the fiduciary obligation

to maximize profits, and a government-chartered and empowered agency with a public mission. It should be obvious that it cannot achieve both objectives. If it maximizes profits, it will fail to perform its government mission to its full potential. If it performs its government mission fully, it will fail to maximize profits.

[T]he incentives of their managements [are] to increase their own compensation.

This has direct consequences in the real world. Since 1992, Fannie and Freddie have had an obligation to assist in financing affordable and low income housing. Obviously, doing so would be costly, and would thus reduce their profitability. Studies now show that their performance in financing low income housing-especially in minority areas- is far worse than that of ordinary banks. In other words, despite the fact that Fannie and Freddie receive subsidies to perform a government mission-in this case support of low income housing-their need for and incentives to retain a high level of profitability is an obstacle to their performance.

Other GSEs--and here I am thinking specifically of Fannie Mae and Freddie Mac--while they hold a government charter, are much closer to the business corporation model. They have actual shareholders, are listed on a securities exchange, and in terms of the way they present themselves to the financial markets are profit-maximizing entities. Although five of their directors are appointed by the president, I am told that these directors are advised by counsel for Fannie and Freddie that their duty of loyalty runs to the corporation and its shareholders and not to any stakeholder or any government mission.

[T]he subsidy realized by Fannie and Freddie is the worst kind of corporate welfare--a transfer of wealth from the taxpayers to both the generally well off (Fannie and Freddie's investors) and the genuinely wealthy (Fannie and Freddie's managements).

We understand from the rules of corporate governance that the directors of corporations like Fannie Mae and Freddie Mac are expected to serve the interests of the corporation and the shareholders by seeing to the maximization of profits. The fact that they have a government mission is irrelevant--as is, we are told, the fact that some of them are appointed by the president. So, in a quite literal sense the directors of Fannie and Freddie face a conflict between the government mission of their corporations and their duty to

maximize profits for shareholders. Any claim that they are discharging a public trust is an illusion. To the degree that they do anything less than maximizing profits it is to maintain their valuable franchise by reducing their political risk, not because they are voluntarily fulfilling some public trust. It can't be otherwise; they are legally bound to a duty only to the corporation and its shareholders.

This is very clearly seen in Fannie and Freddie's activities in affordable and minority housing. Study after study has shown that they are doing less for those who are underserved in the housing market than banks and thrifts. Not only do they buy fewer mortgages than are originated in minority communities, the ones they buy tend to be seasoned and thus less risky. Despite Fannie's claims about trillion dollar commitments, they are meeting their affordable and minority housing obligations by slipping through loopholes in the loosely written and enforced HUD regulations in this area.

In other words, two companies that are immensely profitable and claim to have a government mission, are doing as little as they can get away with for those who most need assistance--while swamping the airwaves with advertising that they are putting people in homes. This should be no surprise, since their incentives push them in this direction. As shareholder-owned companies, they are maximizing their profits--as they must--while doing just enough to avoid the criticism that might result in the loss of the government support that enables them to earn these profits.

Wallison dismisses the concept that Fannie and Freddie's senior managers (the "genuinely wealthy") even consider the public interest - their "government mission is irrelevant" to their decision-making. He explains that Fannie and Freddie's leaders act like fully private CEOs.

Fannie and Freddie suggest that they provide special assistance to minority families hoping to become homeowners. And if they did this disproportionately--that is, helped minorities or low income borrowers more than they helped middle class borrowers--that would be a powerful argument for preserving their current status.

But they do not do this. Instead, according to a study by Jonathan Brown of Essential Information, a Nader-related group, Fannie and Freddie buy proportionately fewer conventional conforming loans that banks make in minority areas than they buy in middle class white areas. Other studies have shown that the automated underwriting systems that Fannie and Freddie use to select the mortgages they will buy approve fewer minority homebuyers than similar automated underwriting systems used by mortgage insurers.

The sad fact is that Fannie and Freddie--two government sponsored enterprises that have a government housing-related mission--do less for minority housing than ordinary commercial banks. Studies have repeatedly shown that banks and other loan originators make more loans to minority borrowers than Fannie and Freddie will buy. That in itself should be a scandal, together with the fact that both companies seek through their soft- focus advertising to create the impression that they are actually using their government benefits for the disadvantaged in our society.

Wallison's verbal assault on Fannie and Freddie was vigorous. He viewed their failure to make more loans to minorities to be a "sad fact" and a "scandal."

I will begin the explanation in this column of why Wallison's lack of understanding of accounting fraud leads him to err in his view that Fannie and Freddie's senior managers were acting to fulfill their fiduciary duties to the shareholders. (It's an odd error for a man whose normal premise is wealth maximization. As with "public choice" theory, the neoclassical prediction should be that the CEO will act to maximize his wealth - not the shareholders' wealth. Term it "CEO choice theory.") Wallison does not understand that Fannie and Freddie's controlling officers would come to see that purchasing large amounts of "liar's" and subprime loans was an ideal strategy for short-term wealth maximization. Nonprime mortgage loans made it easy for Fannie and Freddie's senior officers to supply the first two ingredients in the four-part recipe by which lenders (and purchasers of loans) that are accounting control frauds maximize short-term accounting income.

1. Extreme growth

2. Through making bad loans at premium yields

3. With extreme leverage, and

4. Providing only trivial loss reserves

As Akerlof & Romer (1993) explained, accounting fraud is a "sure thing." A lender that follows the recipe is guaranteed to report record income in the short-term, which translates to making the senior officers wealthy. The SEC's complaint against Freddie's senior managers stated that the reason they caused Freddie to engage in accounting fraud was to maximize their compensation. Fannie and Freddie's CEOs eventually came to see that there was no conflict between their desire to become personally wealthier and purchasing bad loans with high nominal yields (and real losses).

Wallison is correct, however, that it was only after Fannie and Freddie's use of an alternative accounting fraud scheme based on rapid growth and taking serious interest rate risk was discovered by the SEC and ordered terminated by OFHEO that Fannie and Freddie vastly

increased their purchase of nonprime loans and MBS. Fannie and Freddie were late to the nonprime party - the giant investment and commercial banks were the leaders in securitizing toxic mortgages to form toxic collateralized debt obligations (CDOs).

In part, I blame HUD for letting Fannie and Freddie get away with this. Over both Republican and Democratic administrations, HUD has failed to adopt regulations that would require Fannie Mae and Freddie Mac to use a significant portion of the profits they derive from their government support to add appreciably to the housing finance resources available to low-income families. This is in part because the HUD regulations establish a single broad category for low and moderate income families--allowing Fannie and Freddie to meet their requirements through the purchase primarily of moderate income mortgages--and also define underserved areas so broadly that Fannie and Freddie are not compelled to purchase many of the mortgages that banks and thrifts make in meeting their CRA obligations. In a memorable demonstration at an AEI conference two years ago, Jonathan Brown of Essential Information showed aerial views of Chicago neighborhoods with overlays for areas where Fannie and Freddie were and were not purchasing mortgages. Brown's overlays showed clearly that the low income and minority areas of Chicago were being bypassed by Fannie Mae and Freddie Mac.

To be sure, the jury is still out on the Bush administration's stewardship of HUD. In a June speech, the President identified increasing home ownership for minorities as a key goal of his administration. In October, he hosted a conference on minority home ownership, where he proposed a $200 million fund to provide up to 40,000 minority families with downpayment assistance. An amount of this size would be a fraction of what Fannie and Freddie earn each year through their government support. It may well be that HUD, in vigorously pursuing all avenues to advance the President's program will seek to tap this source in some significant way. I hope so, but it remains to be seen. Only then, albeit under duress, will Fannie and Freddie be in any sense fulfilling the public trust of a GSE.

In recent years, study after study has shown that Fannie Mae and Freddie Mac are failing to do even as much as banks and S&Ls in providing financing for affordable housing, including minority and low income housing. After studying the issue for years, HUD has finally proposed regulations that would tighten the definitions of such terms as "low and moderate income," "underserved areas," and "very low income families." Then HUD set a goal that required Fannie and Freddie to devote increasing percentages of their total business to assisting families in the affected groups to become home owners.

In the regulations we will be considering in this conference, HUD is making a valiant effort to bring the activities of Fannie and Freddie into alignment with their statutory mission and with their advertising claims..

Wallison "blame[d]" HUD for not cracking down on Fannie and Freddie's relatively small purchases of loans to poorer minorities. He noted with relief that HUD had "finally" decided to crack down after reviewing "years" of "study after study" demonstrating that Fannie and Freddie purchased fewer nonprime loans than did the large banks. Wallison called HUD's new effort "valiant. He wrote "I hope so" in reference to the possibility that President Bush would compel Fannie and Freddie to increase greatly their provision of affordable housing loans.

[I]t is doubtful that any set of regulations and any enforcement would be successful in driving these companies in a direction they do not want to go. That is the subtext of the discussion today.

There is a cottage industry in former Fannie and Freddie officers trying to claim that they were forced to purchase bad loans by the government to help poorer Americans. Wallison never believed it then, but he purports to believe it now when it is useful to his historical revisionism.

Wallison was Concerned about Fannie and Freddie's Interest Rate Risk, not Credit Risk

Wallison gave this testimony in the context of the SEC's exposure of Fannie and Freddie's accounting fraud. The scheme was to take substantial interest rate risk. Freddie bet that rates would fall and Fannie bet they would rise - they fell. If the gamble worked the firm would report record profits and maximize the officers' bonuses. Indeed, Freddie's profits were so large that it (unlawfully) created "cookie jar" reserves that it could draw on in lean quarters to "hit the number" and maximize executive bonuses. Fannie unlawfully hid the losses on its interest rate bets by improperly calling them hedges. Wallison's emphasis was always on Fannie and Freddie's interest rate risk. In order to optimize the accounting scam, Fannie and Freddie had to grow rapidly by holding loans and MBS in portfolio so that they could take much larger interest rate bets. When Fannie and Freddie sell MBS they transfer the interest rate risk to the purchaser.

These are two very different ways of performing their functions, and have very different consequences. When Fannie and Freddie create pools of mortgages and sell MBS backed by these pools, they are guaranteeing that investors will receive a stream of revenue derived from the interest and principal paid into the pools by homeowners paying off their mortgages. In this case, Fannie and Freddie are taking only credit risk--the risk that homeowners will not meet their mortgage obligations. This is not a very significant risk, especially today, when losses on mortgage pools have been running at 1 or 2 basis points.

However, buying and holding mortgages or MBS is an entirely different story. In that

case, Fannie and Freddie must take interest rate risk in addition to credit risk. Interest rate risk--that rates will rise or fall--is a far greater risk than credit risk, and requires Fannie and Freddie to buy derivatives of various kinds to protect themselves against the vicissitudes of the credit markets. To put this in perspective, it was interest rate risk that caused the failure of the S&Ls.

Wallison's incomplete Understanding of Accounting Control Fraud

Wallison gets many of the elements of control fraud correct, but he comes from such a warped perspective when it comes to accounting fraud that he never quite gets it. The irony is that Franklin Raines, Fannie's CEO during much of the time that Wallison was focused on Fannie and Freddie, could have taught Wallison everything he needed to know. In response to the Enron-era accounting control frauds the Business Roundtable made Raines its spokesperson on fraud and integrity. Business Week interviewed him on May 19, 2003.

We've had a terrible scandal on Wall Street. What is your view? Investment banking is a business that's so denominated in dollars that the temptations are great, so you have to have very strong rules. My experience is where there is a one-to- one relation between if I do X, money will hit my pocket, you tend to see people doing X a lot. You've got to be very careful about that. Don't just say: "If you hit this revenue number, your bonus is going to be this." It sets up an incentive that's overwhelming. You wave enough money in front of people, and good people will do bad things.

Wallison's description of accounting control fraud at Fannie and Freddie is confusing. He could not seem to believe that the GSEs were in grave danger because of their leaders and business practices.

It is important to recognize the significance of the accounting problems at Freddie Mac- -not because these problems are especially severe, but because they were a surprise and seem to arise from something so routine. From press accounts, it appears that Freddie attempted over many years to manage its earnings by manipulating the valuation of its derivatives. This is known as managing earnings, and its objective is to create a smooth upward curve. Freddie Mac was so good at this that it was nicknamed "Steady Freddie" on the Street. Some attention is now also being paid to Fannie Mae's financial reports, which, despite the vicissitudes of the mortgage market, interest rates and the economy

generally, also showed the same smooth upward curve. Managing earnings is very easy to do under Generally Accepted Accounting Principles (GAAP)--so easy that many companies are suspected of doing it.

Wallison's use of the word "routine" is simultaneously accurate and enormously disturbing. He is correct that many of our most elite corporations deliberately manipulate their financial statements. It is disturbing that Wallison does not find that alarming and does not understand how much damage it causes. He actually believes that it is lawful to manipulate the earnings and it does not appear he believes it raises any moral issues.

The fact is that GAAP financials are highly malleable, and should not be considered an index of the financial condition or prospects of companies. Because the principal constituents of a GAAP earnings statement are predictions about the future--what losses will be suffered on a portfolio of receivables, what reserves should be established for future claims--bottom line financial results reflect simply the judgments of management rather than a true picture of the company's financial condition.

Again, this passage has some basis in reality and is disturbing both for what it says about business elites and the nation's leading apologist for those elites. Yes, GAAP statements are exceptionally "malleable" if the senior officers choose to act like a blacksmith and hammer them into the shapes that the CEO desires. The fact that reserves require judgments about the likelihood of future events does not mean, as Wallison appears to believe, that the CEO and CFO can put in whatever number will maximize their bonuses. And if he does think it means that then he should be working feverishly to end it.

.Because of the uncertainties associated with GAAP, it is not correct to believe that Fannie Mae and Freddie Mac are financially strong companies simply because they are producing earnings or have strong-looking balance sheets. It's likely that they are both profitable and financially strong, but we really can't know for sure. A demonstration of this is the fact that OFHEO--Fannie and Freddie's regulator--was not aware of the true extent of the company's financial problems until advised of them one day before they were announced. If their regulator could not find their financial problems, how is the general public--or Congress--supposed to do it?

This passage contains a critical understanding. Fannie and Freddie's managers could - at will - produce financial statements that made them look exceptionally profitable even when they were in fact suffering losses. Moreover, they could get a clean opinion from a top tier audit firm and they could deceive their regulator. Taken together, that meant that if the senior officers were wealth-maximizers they could easily find accounting control fraud to be their optimal strategy. Wallison seemed to understand that the frauds came from the top.

But in relying on regulation we are again deluding ourselves. Occasionally, regulators stumble upon things like bad accounting, but in most cases they are in the dark until someone tells them about the problem. Thus, I don't blame OFHEO, or believe that it is a weak or incompetent regulator because it failed to uncover or understand the gravity of the accounting problems at Freddie. This is what we should expect from any regulator, because it is the most likely outcome. Regulators work in the bowels of the organizations they regulate, but the big decisions--the ones that can really cause the losses at a company--are made at the top level, where regulators generally have no regular access.

Wallison missed the fact that competent regulators always focus on the CEO. The Bush administration had overwhelmingly appointed regulatory leaders on the basis of their anti- regulatory dogma, so Wallison didn't have many effective role models.

Until June of this year, when Freddie Mac dismissed its top three officers and announced that it would have to do a considerably bigger financial cleanup than we initially thought necessary, it was possible to say that both Fannie and Freddie were in strong financial condition and that there was no prospect of a bailout. Since then, however, there has been much more scrutiny of the financial statements of both companies, and at least some observers have pointed out that while Freddie might have been more profitable than it reported during the three years ending in 2002, Fannie Mae might actually have lost money, or made no profits, last year. That is not what Fannie reported, which was of course another huge annual increase in profitability. The problem is, because of the malleable nature of Generally Accepted Accounting Principles (GAAP), we don't really know how these complicated companies are doing.

Despite these concerns about Fannie and Freddie's accounting fraud, Wallison did not see credit risk as serious.

Wallison realized that shareholders could not exert effective private market discipline over accounting control frauds. He also knew that the CEO could suborn the internal and external controls and turn them into his most valuable fraud allies.

[T]he Enron collapse called into question the most fundamental beliefs of investors in the United States about how their interests were protected. It is important to keep in mind that investors in public companies have relatively little control over how their funds are used by the company's management. Investors' willingness to purchase equity shares depends on a belief that management will hold to explicit or implicit promises

about how the company will be operated, and in the most general sense this promise is that the company will be operated for the benefit of the shareholders and not the management. To assure that management is observing this commitment, investors rely on several "gatekeepers" or monitors--a belief in the efficacy of corporate governance, in the diligence and honesty of accountants, in the quality of Generally Accepted Accounting Principles (GAAP) as in force in the United States, and in the expertise of securities analysts at the major brokerage firms.

All these monitors failed in this case, and failed spectacularly.

Under these circumstances, when the management of an issuer engages in fraudulent or manipulative practices in connection with the company's disclosures of financial information, and these practices are not caught by the board of directors, by the accountants or by the analysts, there are essentially no safeguards for investors. Since this is what happened in Enron, where a high quality board, a major accounting firm, and virtually all sell-side securities analysts failed entirely to understand or stop a management fraud that was going on right in front of them, it is no wonder that US investors are nervous about whether the safeguards they have been relying on are truly useful. That, in my view, is the true significance of Enron, and accounts for the extraordinary attention this particular fraud has received.

Why did all these controls fail simultaneously? Because the CEO can use his ability to hire, fire, promote, and compensate to create perverse incentives and drive a powerful "Gresham's" dynamic that will select for the least ethical. Again, Fannie would have provided Wallison the perfect example.

Unfortunately, Raines' insights the risk of good people doing bad things stemmed from his implementation of an executive compensation system that gave huge bonuses if Fannie reached the "stretch" goal of $6.46 EPS. Raines knew that the unit that should have been most resistant to this "overwhelming" financial incentive, Fannie Mae's Internal Audit department, had succumbed to it. Mr. Rajappa, its head, instructed his internal auditors in a formal address in 2000 (and provided the text to Raines, who praised it):

By now every one of you must have 6.46 [the earnings per share bonus target] branded in your brains. You must be able to say it in your sleep, you must be able to recite it forwards and backwards, you must have a raging fire in your belly that burns away all doubts, you must live, breath and dream 6.46, you must be obsessed on 6.46.... After all, thanks to Frank [Raines], we all have a lot of money riding on it.... We must do this with a fiery determination, not on some days, not on most days but day in and day out, give it your best, not 50%, not 75%, not 100%, but 150%. Remember, Frank has given us an opportunity to earn not just our salaries, benefits, raises, ESPP, but substantially over and

above if we make 6.46. So it is our moral obligation to give well above our 100% and if we do this, we would have made tangible contributions to Frank's goals [emphasis in original]. (Office of Federal Housing Enterprise Oversight, 2006, p. 4)

Internal audit is the "anti-canary" in the corporate "mines"; by the time it is suborned every other unit is corrupted.

Unfortunately, accounting control fraud would so rock Wallison's anti-regulatory dogma that he keeps stepping back from his ability to even recognize (much less condemn) frauds by business elites as a common problem.

GAAP and all other methods of financial reporting, including International Accounting Standards, are inherently malleable, and results can be easily adjusted by corporate managements to meet predetermined targets. It is possible, perfectly legally and within the rules of GAAP, to produce audited income statements showing results that are highly variable simply by changing predictions about the future--for example, by increasing or decreasing reserves, or depreciation rates.

During that period, the earnings of public companies grew steadily from year to year, frequently hitting to the penny the forecast for quarterly earnings per share made by the sell- side analysts.

This was possible because, wholly legally, companies could hit earnings targets by adjusting one or more of the variable elements involved in the preparation of financial statements under GAAP. This gave rise to claims that companies were engaged in "earnings management," but to no effective cure. In fact, what seems to have been occurring was a game in which analysts and investors were testing the quality of a company's stated earnings by determining whether management could hit its targets. If it could, that meant that the company's earnings were probably growing, although not necessarily as stated. If it could not, that was a signal that the company had run out of ways of adjusting its results to produce earnings growth, and that in turn suggested that its earnings had really fallen quite dramatically. It was because of this that we saw the strange market phenomenon in which companies that missed their earnings targets by a penny or two saw 20 or 30 percent declines in their share prices.

Since there is no "correct" statement of income, and corporate managements were and are in a position to show earnings results within a broad range, smoothing earnings so that they grow gradually over time is not necessarily dishonest, and it is certainly rational. The problem then is not dishonest managements--although there are some--it is excessive reliance on a financial disclosure mechanism--Generally Accepted Accounting Principles--that inherently permits a variety of outcomes.

Let us review the bidding as Wallison describes it. CEOs are able to choose which "earnings" to report from a "broad range" of values. If actual income is negative or too low to maximize the CEO's bonus he will, typically, reduce the provision of loss reserves (for a bank, the ALLL) to be able to transmute a loss into a gain. The CEO picks which earnings to report to maximize his compensation. A CEO that does this "is not dishonest." Indeed, he is "certainly rational."

Wallison is channeling Gregory Mankiw's (President Bush's Chairman of the Council of Economic Advisors) infamous remark as discussant after hearing George Akerlof and Paul Romer present their paper "Looting: the Economic Underworld of Bankruptcy for Profit" (1993) ("it would be irrational for operators of the savings and loans not to loot").

Wallison is a lawyer, and he is read primarily by other lawyers and senior corporate officials. In criminology, we refer to what he and Mankiw did as "neutralization." It's designed to render the criminal and immoral acceptable. Neutralization increases crime. In a word: no. It is dishonest to report false loss reserves in order to make your bonus. It frequently constitutes looting. It typically requires the CEO to commit multiple felonies.

Again, more importantly, if Wallison believes what he is saying then he should study philosophy and ethics and work every day to undue the corrupt culture his anti-regulatory policies have created. His dissent doubts the ethics of subprime borrowers. If he believes what he says about CEOs and CFOs he should place his ethical focus at the top of the food chain.

The key point is that the Republican leadership knew exactly what it would get when it appointed Wallison to the Financial Crisis Inquiry Commission. He was there because he would have to repudiate his entire career before he could ever join in a bipartisan report. The tragic effect is that by trying to discredit the staff's findings Wallison has most benefited the CEOs who have been able to commit fraud with impunity. His apologia for their "rational" "not dishonest" accounting manipulations marks a new low point in his anti-regulatory zeal. He now defends fraudulent CEOs, those he aptly calls the "genuinely wealthy," and claims that they should be able to manipulate the accounting to maximize their bonuses. America needed a unanimous Commission willing to write that Wallison's homo economicus concept of morality is depraved and is producing recurrent, intensifying crises. As authors of the book Moral Markets (a very pro-market volume) emphasize - homo economicus is a sociopath.

Bill Black is the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. He spent years working on regulatory policy and fraud prevention as Executive Director of the Institute for Fraud Prevention, Litigation Director of the Federal Home Loan Bank Board and Deputy Director of the National Commission on Financial Institution Reform, Recovery and Enforcement, among other positions.